Heres how you
screw up current-account adjustment: seek to engineer a
reduction in domestic demand through local-currency
depreciation, rather than interest-rate hikes, introduce
uncertainty and event-risk to monetary policy, and blame the
Fed and speculators when your currency collapses and asset
prices fall precipitously.

Turkey and
Argentina  two distinct economies, with the former
boasting much stronger policy fundamentals  have trod
down the aforementioned path in recent months, seeking a
gradual approach to correcting imbalances with mixed policy
messages.

The
result: their respective
currencies fell to historic lows during the past week amid
a lack of market confidence, triggering panic-selling, with
usually resilient currencies, such as the Korean won and Polish
zloty, coming under pressure.

The fear
is that such localized policy errors will exacerbate the
generalized rout thanks to the prejudice of cross-over
investors, who cast
emerging markets (EMs) as a correlated asset class, prone
to economic mismanagement, say analysts.

In Turkey, the central bank has engaged in a dance of
hiking-in-disguise to avoid the political fallout. On January
21, the central bank kept benchmark short-term policy rates
unchanged despite huge pressures on the currency.

Instead,
the central bank said it would make sure interbank money-market
interest rates will be set at around 9% for the
additional monetary tightening days, making it unclear
whether it would, in practice, deliver tighter liquidity needed
to drive up market rates.

In other
words, instead of hiking rates to contain currency
depreciation, the central bank helped to increase volatility in
rates and asset prices through ambiguous messaging.

Amid the
market fallout, the emergency central-bank meeting on Tuesday,
with a statement expected at 22.00 GMT, suggests authorities
understand the importance of a tighter monetary policy to
contain precipitous lira depreciation.

Argentina is another case in point, where the government is
beginning to capitulate. Last week, the cabinet chief
Jorge
Capitanich announced some controls on purchasing dollars would
be relaxed  for saving purposes  and interest rates
would rise by as a much as 6% at this weeks auction of
peso-denominated bonds.

The policy
efforts aim to contain inflation and reduce demand for dollars
at the parallel exchange rate, where a wide spread to the
official rate reflects distrust in the local currency thanks to
the governments inflationary zeal in recent
years.

However,
there were mixed signals on the scope of the new
foreign-exchange rules while the economy minister reiterated
the governments expansionary policy. Argentinas
heterodox economic policies are well known and the economy is
not included in the fashionable moniker of the
fragile five, markets said to be vulnerable to Fed
tapering, comprising Indonesia, South
Africa, Brazil, Turkey and India.

Instead,
Argentinas latest missteps, like Turkey, underscore the
importance of domestic factors in triggering the recent EM
downtrend, rather than Fed-tapering fears.

Sébastien
Barbé, head of EM research at Crédit
Agricole
CIB, says although there is a
broad consensus that Argentina is a case apart, the
panic-selling last week in response highlights the fragility of
market sentiment.

The
central bank likely decided to devalue because the depletion of
FX reserves was becoming unsustainable, he says.
This rings bells. The fragile five [TRY, ZAR, BRL, INR
and IDR], after all, have also generated worries because of
balance-of-payment and external-liquidity issues, in
particular.

Should the
market move into panic mode, then liquidity fears generated by
Argentina could continue to spread to the fragile
five.

By
contrast, amid a temptation among EM central bankers to suggest
the interest-rate policy tool is not a particularly effective
real-economy mechanism, India highlights how resolute monetary
policy action, together with fiscal measures, can deliver
current-account rebalancing, rebuilding market
trust.

The
Reserve Bank of India (RBI) raised the effective policy rate by
200 basis points in August alone, interbank call money rates
jumped by 360bp during July to September and the RBI introduced
quantitative measures to reduce liquidity, along with
restrictions on gold purchases to reduce Indias import
bill.

As a
result, the economy has undergone massive rebalancing compared
with the other members of the fragile five.

Source:
Haver Analytics

Indias
gradual rehabilitation in the eyes of global markets means it
is being excluded from the fragile-five moniker, with Russia
taking its place.

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